Hedging Against Property Market Decline

[BlowFish 10]

I asked this before a while back, and possibly this is not what James had in mind for this sections so apologies if that is the case.

 

I have a modest property portfolio (all UK based) that I don't want to unwind. I feel that further house price decline is on the cards and would like to minimise the effect of it. Can anyone suggest instruments or tactics to hedge against this decline?

 

Thanks,

[GammaJammer 10]

In very general terms (and to kick off the forum the right way) What I personally would do in your shoes is to try and break your overall risk portfolio down into it's component parts. That way you can seperate them into most likely 3 camps

 

1) Risks you can control and hedge accurately

 

2) Risks you can hedge roughly

 

3) Risks you have no control over

 

So what are the exact factors that would make house prices dip further?

 

An obvious one and good starting point is rate hikes. This probably falls into category 2 unless you have a really accurate model for forecasting just how much your portfolio will take a hit for say a 50bp hike by the BoE. But you can mitigate this risk via interest rate derivatives.

 

Second one - general housing market sentiment. V hard to control, but maybe a proxy can be achieved by constructing a short basket of UK housebuilders? Or even having a SB position on that sector?

 

I'm sure there are otehr factors, but it's not cut and dried what to do. Hopefully this acts as a pointer though.

 

make sense?

 

GJ

[aidaweb01 10]

You could short the 'UK House Price' or 'London Property price' Index found on some spreadbetting sites.

[BlowFish 10]

GJ, yes that makes very good sense - it had not occurred to me to think of things in that way. Aidaweb - thanks for jogging my mind, I thought I had heard of an 'instrument' that tracked some sort of house price index. I wonder how the spread betters lay off there risk if it's not an index that is actually traded?

 

EDIT: Incidentally I am surprised that this is not a fairly common requirement.

[GammaJammer 10]

GJ, yes that makes very good sense - it had not occurred to me to think of things in that way.

 

Very welcome. This is pretty much the essence of portfolio risk management

 

Aidaweb - thanks for jogging my mind, I thought I had heard of an 'instrument' that tracked some sort of house price index. I wonder how the spread betters lay off there risk if it's not an index that is actually traded?

 

At a guess (and it is a guess, but an educated one) otc economic derivatives. Probably a bank will make a market in this stuff. Goldies and Deutsche launched this kind of thing for NFP a few years back and it did well. Have a feeling it's even exchange traded now but don't quote me on that.

 

GJ

[aidaweb01 10]

Aidaweb - thanks for jogging my mind, I thought I had heard of an 'instrument' that tracked some sort of house price index. I wonder how the spread betters lay off there risk if it's not an index that is actually traded?

 

EDIT: Incidentally I am surprised that this is not a fairly common requirement.

 

The instruments I am aware of track either Rightmove or HBOS House Price Index. Its a synthetic product thats not exchange traded (some people have issues with this) but in my experience it accurately tracks the respective indexes. The issue is in the spread which can be quite large, but if you are hedging with a 6-12mth+ timeframe then it's workable.

 

Not sure I understand your question about laying off the risk?

 

I have friends who own very sizable property portfolios in London and I was surprised how little interest they had in the concept of locking in their current profits by hedging. One guy in particular says he's in it for the long long term and is going to ride the 'dip' and not complicate his business by introducing concepts he doesn't understand.

[BlowFish 10]

Re laying off risk this quote from http://www.financial-spread-betting.com/Property-spread-betting.html puts it better than I could.

 

A pretty clear picture of a decisive shift in sentiment is emerging. John Austin, head of proprietary products at IG Index, says that because of this the firm's house price markets are currently suspended and it is only accepting bets to close existing positions. 'There has been such a run of stories in the press talking of meltdown in the housing market that the volume of sell-side business left us with no choice but to close our book to new business for the time being,' he explains.

 

The problem is that there is no easy way for spread betting companies quoting these products to actually hedge their exposure to the house price index. The flipside is that there is a huge degree of interest in these bets. 'We are very eager to get back into the house price market,' acknowledges Austin. 'We have a large exposure to the prices next March and would anticipate that once these figures have been released and the bets settled we will be back taking new positions again,' he adds.

[GammaJammer 10]

 

The problem is that there is no easy way for spread betting companies quoting these products to actually hedge their exposure to the house price index. The flipside is that there is a huge degree of interest in these bets. 'We are very eager to get back into the house price market,' acknowledges Austin. 'We have a large exposure to the prices next March and would anticipate that once these figures have been released and the bets settled we will be back taking new positions again,' he adds.

 

Fine - just mark the price way lower if you're long and worried. P*ssies. That's market making. They just don't like the money if it aint easy.

[aidaweb01 10]

The problem is that there is no easy way for spread betting companies quoting these products to actually hedge their exposure to the house price index. The flipside is that there is a huge degree of interest in these bets. 'We are very eager to get back into the house price market,' acknowledges Austin. 'We have a large exposure to the prices next March and would anticipate that once these figures have been released and the bets settled we will be back taking new positions again,' he adds.

 

I've just been into my IG account and it looks like I can go short.

 

That aside, I totally agree with GJ, making a market when it suits should be outlawed! When Ladbrokes first started offering books they were well known to 'investigate and offer a price' on anything (within legal and ethical boundaries) Thats how they made their name. If IG pull the plug on loss making products they'll quickly lose ground to a companies that don't! P*ssies indeed!

[atto 20]

Fine - just mark the price way lower if you're long and worried. P*ssies. That's market making. They just don't like the money if it aint easy.

Yeah, that doesn't make much sense. I've never heard of a bookie shutting down a line because of overwhelming bets on one side.. just change the line (even if you have to change it a lot), and it will balance.

[BlowFish 10]

This baby looks interesting too http://etf.stock-encyclopedia.com/IUKP-LSE.html

Having trouble getting data for it into my charting package of choice but it looks like it might be useful.

[atto 20]

I'm all for shorting REITs to hedge, but watch out on possible hidden beta exposure. I believe (don't have the hard facts with me right now though) that REITs are more market sensitive than the actual housing market.

[BlowFish 10]

Thanks Atto, If I understand this correctly any company that complies with the appropriate regulatory requirements can get its self listed as REIT? Again if I have got things straight there is and index of all the REIT's (though I can't seem to find a ticker for that so wonder if its traded?) Interesting.

[minoo 11]

http://www.landecon.cam.ac.uk/research/reuag/cambsuncc/cambsunc2007/7_Bertus-Hollan-Swidler.pdf

[GammaJammer 10]

I believe (don't have the hard facts with me right now though) that REITs are more market sensitive than the actual housing market.

 

Stands to reason as it's a long complicated process actually selling a house compared to trading a commoditised instrument.

[BlowFish 10]

Stands to reason as it's a long complicated process actually selling a house compared to trading a commoditised instrument.

 

Which is precisely the appeal of the latter!!

[GammaJammer 10]

But for people / institutions that trade REITS in size, presumably (and I know nothing at all about this market btw) there must be analysts who will pore over the actual portfolio composition of a given REIT and come up with a fair value (roughly at least) for it, trading when price moves away from this become over extended. Or not......

 

Help me out here.....

[GammaJammer 10]

And on that point. Presumably it also means that if an individual were to use a REIT to hedge property exposure (and I don't even know if you can short sell them so this could all be moot) wouldn't one also have to take into account possible tracking error depending on what the property portfolio you are protecting looks like. E.G. hedging a high end London residential portfolio with a commercial property based, Manchester centric property vehicle would presumably not be anything like a perfect hedge (extreme example just to make a point).

 

Am I talking out my @rse here?

[BlowFish 10]

No not at all GJ these are all things that perplex me. I think I need to talk to someone who knows, whilst there is a fair amount of information on the interweb it seems to be largely to attract investors. (invest in property without having to worry about managing a portfolio).

 

The other thing is the composition of the various portfolios (none seem to have much/any residential which is what interests me particularly). I have looked at basic price charts for several and they seem to broadly follow a very similar pattern .......Except a couple with large retail property exposure had massive drops a couple of months ago. Kind of perplexing (as most if not all have some retail element) and worrying too, if you are on the wrong side of such a quick and violent move.

 

Short term volatility looks like an issue too (as may have been mentioned) though as a trader I look at that and think hmm those waves would be nice to trade. Got to keep sight of what the object of the exercise is

[GammaJammer 10]

Presumably a big part of why they are ofen weighted towards commercial exposure is that you can trade bigger 'blocks'. It's unweildy to trade £300k houses if you have a few hundred million to invest - easier to buy a small office block than a bunch of houses, logistically I reckon.

 

I may well be talking out me aris for all I know, but my god I'm convincing sometimes

 

GJ

[BlowFish 10]

Hehe nice to get you out of your area of expertise, I don't feel like such a muppet!

[GammaJammer 10]

Hehe nice to get you out of your area of expertise

 

Not exactly tricky.....

[AgeKay 10]

Hey BlowFish,

 

I don't know whether this issue is still current with you since you opened this thread some time ago (btw, you were right about the property prices dropping), but you could have a look at Eurex' IPD UK Annual All Property Index Futures (PUKA).

 

Not only is it futures, but the contract size is just £50k which makes it easier to reflect your actual portfolio. Don't have any idea about the actual liquidity though (it says minimum quote size is 20 contract [=£1 million in value] which isn't too bad for hedging). I just heard about it when Eurex announced it some time ago.

[BlowFish 10]

Thanks AK,

 

Actually I think it is always 'current'. Obviously adjusting a property portfolio takes a bit more than a mouse click! Any instrument that lets you hedge (even if you are just a simple home owner) is worth investigation.

 

Cheers.

[jasont 10]

This is an interesting discussion and something I personally haven't thought too much into. However a number of things come to mind.

 

The first thing that hits me is your projected time frame of holding the property BF. I am not too sure about Europe but out here in Australia, banks won't force you to get property revalued unless you are changing the mortgage in some way.

 

If you are planning on holding for a number of years to come (as most property investors tend to do unless they are doing renovations and flipping them), then a good hedge in one way is to simply avoid re-financing as much as possible. Of course this is only worthwhile if a) you plan to hold for say at least 10 years and b) you can afford to continue to pay the repayments quite comfortably.

 

There are the smaller details of locking in fixed rates vs variable ones due to the current rate situation but I think that depends on a property value vs repayments cases by case basis on each property.

 

This does appear to be a typical buy and hold strategy where not realizing paper losses doesn't necessarily mean you haven't lost. However it is the same in any type of trading. If you trade intra day, you don't have to close your trade after 2 minutes because it is in the red when you are looking to hold the position for a couple of hours.

 

Shorter term losses can be held onto and unrealized if your view is to hold for much longer. The same as buy and hold investors if their current outlook on stocks is 10 years plus. Even if they bought at the top of this market back in 2007, it may be premature to close out positions now if they wanted to hold into 2020 on most stocks.

 

So really my point based on what happens out here in Australia, there may not be a need to hedge against one's property portfolio beyond trying to increase rent, if banks don't force you to re-value your property and you plan on holding long term.